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Gov’t Report Suggests Fixes for Broken Unemployment Insurance System

A GAO reports suggests ways to allow state unemployment funds to become more solvent, including increasing the base wage that can be taxed and eliminating free loans to states to shore up their funds.

Hundreds of people looking for employment wait in line at an AARP job fair on April 12, 2010, in New York. (Spencer Platt/Getty Images)As we've previously reported, state unemployment insurance systems are in crisis.

Some 33 states have run out of money to pay benefits and have been forced to borrow nearly $38 billion from the federal government just to keep benefits flowing to unemployed workers. Those financial difficulties are also taking a human toll as states scramble to replenish their funds through tax increases and limits on benefits.

A report released by the GAO (PDF) today both points to this pressing problem, and confirms our report from last year showing that much of the blame lies with states, many of which maintained dangerously low levels of reserves even before the recession began.

Going one step further, the report outlines policy changes that are on the table to prevent a repeat of this mass insolvency (which itself is a repeat of solvency crises in the 1970s and 1980s), including:

Increasing the minimum taxable wage each year: The federal government mandates the minimum of a worker's wages that can be taxed. Problem is, the minimum has thus far been a absolute dollar amount -- $7,000, set back in 1983 -- that has been allowed to dwindle away with inflation. The GAO suggests indexing this number, meaning the minimum would automatically increase each year with workers' wages.

Our analysis: Some states do this already -- Washington state taxes the first $36,800 of each worker's wages, for example. While it is not a cure-all because some states with high minimum taxable wages still face solvency issues, overall these states are in better shape than states like California, which still taxes the minimum $7,000. Also, since this is a federal policy change, it would be easier to enact and implement than a change that requires herding all 50 states, D.C., Puerto Rico and the Virgin Islands.

Crack down on states free-riding with interest-free loans from federal taxpayers: If a state's fund goes insolvent, the state can currently borrow money interest-free for a time from the federal government to pay unemployment insurance benefits. But the ease of getting these loans may be encouraging states to underfund their systems knowing there is a federal safety net. As the GAO notes, the Department of Labor is considering making it tougher to get these loans, and potentially more financially painful to maintain a balance.

Our analysis: Cash for these loans to states is now coming directly from the U.S. Treasury, which means taxpayers in states with responsible policies are helping bail out states that benefited from low taxes during good times. Making the loans harder to get could encourage states to plan more carefully for recessions, but the tough love approach may also penalize states like Michigan that haven't been able to accumulate reserves because they haven't seen good times for years.

Change state tax structures: States adjust employer tax rates up and down depending on how many layoffs they have had in the past under the theory that employers who've laid off more workers, who are in turn drawing money out of the system, should pay more into it. Two proposals the GAO flags would change this system. One would ask employers to pay more, even if they haven't laid off employees recently. (Some states allow employers who haven't had recent layoffs to pay very little in taxes. In South Dakota, until this year employers paid nothing in taxes if they had no layoffs in the past three years.) The other proposal would ask employers to pay more if they have an extensive layoff history, under the theory that this would discourage layoffs.

Our analysis: Letting employers pay a negligible amount for unemployment insurance is kind of like saying my car insurance should be free if I've never had an accident. The idea is to pay into the fund before you need to take money out.

Whether that will happen is an open question for many states: The proposed changes would have to happen in state legislatures, where the influence of business looms large. Because relatively few businesses pay the highest tax rates, it may be easier to increase them than the lowest tax rates. But the industries with large numbers of layoffs, like construction and manufacturing, account for a large share of the economy in some states. And, in all states, there is a temptation to reduce taxes back down when the trust fund is flush.